TESTING A NEW PARADIGM December 16, 1997 NEWSHOUR TRANSCRIPT

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The United States' stellar economic performance has many experts, including Federal Reserve Chairman Alan Greenspan, worried about inflation. But not all who study America's financial health are concerned. There are those who claim that the absence of inflation is okay, and can be explained by using a new economic paradigm. Correspondent Paul Solman of WGBH Boston puts this theory to the test.

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A RealAudio version of this segment is available. NEWSHOUR LINKS: December 5, 1997 The U.S. unemployment level drops to 4.6 percent. December 5, 1997 Silicon Valley continues to grow. November 26, 1997 A review of the APEC Conference. November 7, 1997 The rise of money managers. October 28, 1997 The NYSE registers its single largest point gain in history. October 28, 1997 Exploring the causes and effects of Asia's fluctuating markets. October 23, 1997 A 10 percent drop in the Hong Kong stock market makes investors uneasy. October 14, 1997 This year's Nobel Prize winners for economics explain their formula for pricing options. August 15, 1997: Economists explain the day's stock market plunge. March 31, 1997: Paul Solman looks at what makes the stock market move. Browse the NewsHour's coverage of business and economy. OUTSIDE LINKS Federal Reserve New York Stock Exchange NASDAQ EduStock: an educational site that explains how the stock market works.

PAUL SOLMAN: Headlines have proclaimed it. We're living in a new economy featuring low inflation. Is the great inflation over, they ask. Is inflation gone for good? Well, if it is, it's a big deal, because inflation has haunted the 20th century. The hyperinflation of Germany in 1923 is widely thought to have discredited government there and paved the way for Hitler. In 1948, hyperinflation raged in China.

SPOKESMAN: You needed a ricksha, instead of a purse or wallet, to go shopping.

The new economic paradigm.

PAUL SOLMAN: The U.S. has never experienced hyperinflation, but the fear of spiraling prices has long been a key concern, and the Federal Reserve, founded to control financial panics, has instead become, first and foremost, an inflation fighter, raising interest rates whenever it thought unemployment was getting too low; the economy, too high. But now some economists are standing this kind of thinking on its head. Ed Yardeni of Deutch & Morgan Grunfeld says we're in a new era, with a new economic paradigm; it's key feature that global competition has killed inflation.

ED YARDENI: The old era risk was inflation. In the old era growth was bad. If you grew too rapidly in tight labor markets, labor costs went up; you had more price inflation; it got passed right into prices, right? Then the Fed would raise interest rates, and you would have a recession. So rapid growth was ultimately bad because it would lead to recession. In the new era competition keeps the lid on inflation.

PAUL SOLMAN: So, says Yardeni, inflation fighters like the Fed's Alan Greenspan should finally stop worrying about low unemployment and an overheated economy, because global competition has forced U.S. "productivity"--the amount a guy like this can produce--to grow faster than his wages, thus helping keep inflation at bay in America. Well then, isn't this a new paradigm? Economist Nick Perna doesn't think so.

NICK PERNA: Isn't there an old song "Buddy, Can You Spare a Paradigm"? I'm not sure. I think the mistake that is being made by many people is to confuse things that are permanent with things that are transitory. We are decidedly on a lower inflation path than we've been in the last 20 or 25 years. To then say that we can go to lower inflation, or that we either can sustain the current rate of economic growth, or accelerate it, to me is not only being silly, but flirting with danger.

PAUL SOLMAN: Okay, how do you test the idea of a new paradigm? Well, we thought we'd take a look at a real company to get some on-the-ground answers to the lofty question: Is inflation dead?

Testing the new paradigm.

PAUL SOLMAN: This is Murray Gerber, CEO of Prototype and Plastic Mold, just outside Hartford, Connecticut. Gerber employs 80 people, from high-tech mold makers who design plastic gizmos, like the latest Piper airplane steering wheel, to low tech assembly workers who make them. At Gerber's firm, we found evidence in support of Yardeni's thesis: Competition has, he says, forced him to keep his prices down. In fact, in the early '90s--

MURRAY GERBER: Our biggest customer came to us and said starting tomorrow, you will reduce your prices to us by 20 percent, or we will take the business away from you.

PAUL SOLMAN: Prototype was feeling the heat of ever keener competition--global competition, with lower prices due to efficient new manufacturing technology, for example, and new management methods in economies like Japan; lax government regulation of pollution and worker health and safety; cheaper labor, kept cheap by the suppression of unions. Global competition was forcing firms like this to lower their prices, but mainly by increasing productivity through labor-saving technology and techniques, instead of dropping wages or regulations.

MURRAY GERBER: We used to have a person who did nothing but schedule all of our molding machines. Now what we do is we put all the work for the molding machines up on the board for five weeks, and we have team leaders who come up and pick the jobs that are going to be run next. The scheduling is sent without anybody directing it.

PAUL SOLMAN: This so-called "Kanban" scheduling board was a Japanese productivity improvement. Another cost-saving innovation was simply putting casters on these once immovable objects: Bridgeport milling machines.

BOB COOK: Well, originally I'd make a plate that operators would read at the molding machine and not learn how to do the secondary operation. So what, we did here is we brought in the older machines and we put them on wheels, and we rolled them right up and we created mini cells.

PAUL SOLMAN: The "mini-cells" eliminated jobs in packing and inspection by having such tasks done at the molding machines themselves. The net result? Huge productivity gains. Murray Gerber worked especially hard for his biggest client, the one who demanded he cut costs by 20 percent.

MURRAY GERBER: And I am pleased to say that what we started with was a market basket of parts for one of their products that started at $24 is now under $9. And we are making more money on it than we did at $24.

The workers' perspective.

PAUL SOLMAN: Okay, so far, so good. According to the new paradigmers, global competition has meant lower prices, which US firms have had to match with increased productivity. And in fact that's just what we found at Murray Gerber's place. But now here comes the key point regarding inflation. Significant productivity increases have usually led, in the history of American business, to significant increases in wages. That is, the workers wind up sharing much of the windfall that comes from producing more with less. But the workers we interviewed at Gerber's factory were unanimous.

RITA LEWANDOWSKI: We're doing a lot more stuff now at the machines; at least two to three extra procedures.

PAUL SOLMAN: And so you personally are getting a lot more accomplished?

RITA LEWANDOWSKI: Yes.

PAUL SOLMAN: Do you get paid accordingly? Or do you get paid more as a result?

RITA LEWANDOWSKI: No.

PAUL SOLMAN: Have your wages gone up as much as your efficiency?

MIKE CONLEY: No, no. No, no, no, no, no. Not by any stretch of the imagination.

PAUL SOLMAN: And when you project ahead into the future do you think your wages will go up to reflect your efficiency or still lag?

MIKE CONLEY: I think, to be honest with you, I think it will still lag.

PAUL SOLMAN: Even Bob Cook hasn't seen his salary go up.

PAUL SOLMAN: You, I take it, are more productive, significantly so, than you were say five years ago?

BOB COOK: Most definitely

PAUL SOLMAN: Do you get paid as much more as you are more productive?

BOB COOK: No.

PAUL SOLMAN: Okay, what's happened here? Well, the workers, it seems, have been willing to settle for a secure job and steady paycheck, and they show no signs of pushing for wage increases that would in turn push up inflation.

SHEILA KROL: I wouldn't mind getting more money, but as long as he makes a profit and stays in the company and has a stable job and pretty secure, yes, I feel much better coming to work.

MURRAY GERBER: There is a great amount of angst among workers. And, you know, when you speak about drivers of inflation, I think that angst is keeping workers from coming and pounding on their bosses' desk, and saying, "If you don't give me a 10 percent raise, I'm going to leave."

PAUL SOLMAN: So Prototype, it would seem, is an example of the new, inflation-free paradigm. We confronted traditionalist Nick Perna with our case in point. And he had a pretty strong comeback.

NICK PERNA: But this is manufacturing. And manufacturing is what? Twenty percent of the U.S. economy. And since time immemorial, productivity growth in manufacturing has exceeded productivity growth in the economy as a whole. For any number of reasons it's a lot easier to mechanize manufacturing than it is to mechanize a retail store. I think what you need to look at is not simply manufacturing, but the overall economy.

PAUL SOLMAN: The overall economy, Perna points out, is dominated by service industries, featuring workers as diverse as croissant flippers, export shippers, microphone grippers. And as economist William Baumol famously observed, productivity gains in services can be hard to come by. "You can't play a piece of music any faster today," Baumol wrote, "than you could 150 years ago." But Ed Yardeni thinks global competition is putting downward pressure on costs throughout the service sector as well, causing productivity to rise through computers and the Internet, for example. But again, while productivity here is rising, wages are being held down, Yardeni says, by global competition.

ED YARDENI: Even I feel that I face global competition. And I had an e-mail from a fellow in Beijing, who said that he studied physics in China, had come to the U.S. and studied economics, with a Ph.D, went back to China, now he would love to come and work for me. And this guy is like my worst nightmare. If I hire him, he'll probably wind up taking my job. And if I don't hire him, he'd probably do it over the Internet. So one way or the other, I think we all face global competition.

PAUL SOLMAN: Okay, say you grant that there's been some increase in service sector productivity, in industries like financial services at least. Even so, a growing economy usually means less and less unemployment, upward pressure on wages, and thus, eventually, says Nick Perna, inflation.

NICK PERNA: And if the economy continues to grow at the same pace it's been growing for another year--which seems unlikely now for a variety of reasons--but if it were to continue to grow, the unemployment rate would fall further. And I think the conversation that you would be having with me and with other people is not when the inflation rate is going to pick up, but how much is it going to pick up by.

PAUL SOLMAN: Perna points to headlines like these: the Army is having trouble finding recruits; companies are running job fairs to attract employees; Orlando, Florida is importing workers from Hungary, Poland and the Ukraine. It's only a matter of time before tight labor markets like these, he says, lead to higher wages. To Federal Reserve Board chairman Alan Greenspan, data like these that make the new paradigm talk worrisome, especially when it's extended to economic policy.

Chairman Greenspan's warning.

ALAN GREENSPAN: Regrettably, over the last year the argument for the so-called new paradigm has slowly shifted to a less than credible view, often implied rather than stated, that we need no longer be concerned about the risk that inflation can rise again.

PAUL SOLMAN: But to new paradigmist Ed Yardeni, our Connecticut case studies suggest inflation has been whipped, at least for the foreseeable future.

ED YARDENI: I think the notion that this is a new paradigm has been misinterpreted to mean that this is a new era, a golden era. Well, I do believe this is a new era of tremendous competition, keeping a lid on prices. All I'm saying is that competition is going to mean that inflation is dead. As long as inflation is dead, that, to me, proves that this is a new era.

PAUL SOLMAN: Well, today the Fed met and did not raise interest rates, despite the lowest unemployment in decades. This time it was probably fear of Asian instability that kept the Fed from acting, which only means the new paradigm debate has been left for another day.

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